While most of the world's governments are still focused on defeating the novel coronavirus that has plunged the global economy into its worst slump since the Great Depression of the 1930s, central bankers are gearing up to tackle what could become one of the biggest financial challenges of the next decade: digital currencies.
The People's Bank of China, the central bank, which started research on a digital yuan as far back as 2014, is leading the field and China is likely to be the first major economy to introduce a sovereign digital currency -- it was beaten to the top spot by the Bahamas, whose central bank launched its Sand Dollar in October. The PBOC has already finished building the infrastructure for its Digital Currency Electronic Payment (DCEP) system and has been carrying out local testing in cities, including Shenzhen and Suzhou, although no date has been set for its official launch.
Draft revisions to the central bank law published Oct. 23 include clauses that provide the legal framework for the DCEP, giving the digital yuan the same legal status as the physical yuan. And China's long-term plan for the economy through 2035, released after the Fifth Plenum of the Communist Party Central Committee that took place at the end of October, refers to "steadily advancing digital currency research and development."
As it gears up for the domestic launch of the DCEP, China also wants to make sure it has a seat at the global digital-currency table. Over the past few months, President Xi Jinping has highlighted the need for China to get involved in setting international standards and formulating global rules to handle risks to make sure it retains its competitiveness.
"We should ... actively participate in formulating international rules on digital currency and digital tax to create new competitive advantages," Xi wrote in an October article published in Qiushi, the Communist Party's main theoretical journal. And in a speech at a summit of leaders from the Group of 20 nations on Nov. 21, he called for the organization "to discuss developing the standards and principles for central bank digital currencies (CBDCs) with an open and accommodating attitude, and properly handle all types of risks and challenges, while pushing collectively for the development of the international monetary system."
China has left the rest of the world in the dust when it comes to digital currencies, although that shouldn't come as much of a surprise given the way the government and domestic companies such as e-commerce giant Alibaba Group Holding and its fintech affiliate Ant Group have used digital technology to transform China's backward banking and financial architecture into a cutting-edge, online-focused and user-friendly system for the internet era.
A survey of 66 major central banks carried out by the Bank for International Settlements toward the end of 2019, showed that 80% were engaged in some form of CBDC work, up from 70% in the previous survey in 2018. Of the 80%, only 10% had gone as far as developing pilot projects and all of them were in emerging-market economies. Some 40% of those doing CBDC work said they had progressed from conceptual research to experiments, or proofs-of-concept, where they had carried out feasibility tests to verify whether the currency had practical potential.
That change has been partly prompted by the rise of cryptocurrencies such as Bitcoin, and by Facebook's announcement in June 2019 that it was working on a project to launch a global blockchain-based digital currency, Libra. Although the social media giant's proposal has since been watered down to a more run-of-the-mill payment system, it focused the minds of officials at national and international level on the future of money -- how it is spent and transmitted, how it is regulated and how to control the risks stemming from cryptocurrencies, including stablecoins and other digital payment systems.
Research into digital currencies has taken on added momentum in the wake of the COVID-19 pandemic, which led to an acceleration in the use of digital payments, fueling concern that hundreds of millions of consumers, especially the elderly and the "unbanked" -- those without access to banking facilities -- will be shut out of the financial system. The proportion of contactless payments in global card transactions increased to more than 33% in March as the pandemic raged around the world, up from around 27% six months earlier, according to the BIS.
The year 2020 "has been a watershed moment in the attitudes of many central banks around the world towards CBDC," Benoit Coeure, a member of the BIS's Executive Committee, told Caixin in an interview in October. While Libra has accelerated central banks' move toward CBDCs, it is technological innovation that is fundamentally driving the change, he said earlier in June.
The Bank of Japan, in its October paper, "The Bank of Japan's Approach to Central Bank Digital Currency," said it would start testing the basic functions of CBDC as a payment system in 2021. The same month, the European Central Bank published a report on the possible issuance of a digital euro, and said that it would decide whether to launch a digital euro project around the middle of next year.
The U.S. Federal Reserve has been more circumspect. When the BIS approached other major central banks about setting up a group to study digital currencies, the Fed initially declined to get involved, a senior central banker close to the group told Caixin. But after the group was formally launched in January 2020, the Fed changed its mind and joined the six other founding central banks, which included the Bank of England and the European Central Bank. Its name appeared on the first report issued by the group in October discussing the common principles and key features that a CBDC and its supporting infrastructure should have. The Fed's chairman, Jerome Powell, said it was more important for the U.S. to "get it right than it is to be the first."
Over the past year, Chinese central bank officials have attempted to clear up confusion and misunderstandings about the DCEP, how it fits in to the country's monetary policy and system, how it changes the role of the dominant third-party payment systems Alipay and WeChat Pay, and how China's approach to its digital currency differs from other countries. Those efforts have coincided with the rollout of testing of the currency in retail settings in three cities -- Shenzhen, Suzhou and Chengdu -- and the Xiong'an New Area, a development hub for the Beijing-Tianjin-Hebei economic triangle.
Mu Changchun, the head of the PBOC's digital currency research institute, and Fan Yifei, the central bank's deputy governor, have spearheaded those efforts, giving speeches and writing commentaries to explain the rationale behind the DCEP. Their message is that issuing a sovereign digital currency will maintain the PBOC's control over the financial sector and monetary system; neuter the threat posed by Libra and other cryptocurrencies; provide a backstop to the existing mobile payment infrastructure, which has become systemically important; promote financial inclusion by making electronic payments more accessible to people without bank accounts; and combat money laundering, financial fraud, and terrorism financing.
Mu has repeatedly emphasized that DCEP is a replacement for cash and will be centrally controlled by the PBOC. The technology behind the currency will enable people to send and receive funds by touching each other's phones regardless of whether or not they are connected to the internet, a feature Mu says is a clear advantage over Alipay and WeChat Pay.
China's focus in developing DCEP has been on domestic use by consumers for retail payments, rather than on "wholesale" use related to settlement and payment between institutions in financial markets, or for cross-border payments, with the aim of making them more efficient and transparent, and easier to regulate. That's partly because China has a huge informal economy that is driven by cash payments, and breaking the cycle will help the government control corruption, illegal cash flows and tax avoidance, among other things.
But longer term, as China's financial system becomes more developed, the DCEP would be conducive to the internationalization of the yuan, Mu said in a speech last year.
That's one key reason why China is pushing hard for common global standards for digital currencies and for increased coordination among international financial authorities to regulate them. The PBOC has already been contributing to work on standards. A paper published by the central bank's digital currency research institute in 2019 noted that China was the first to add digital currency-related content to the repository for ISO 20022, a new global standard covering financial information transferred between financial institutions that includes payment transactions, securities trading and settlement information, and credit and debit card information.
The paper's authors said China's efforts to fill the gap have not only expanded the scope of the application of the new ISO 20022 standard, but also helped promote the internationalization of China's digital currency standards and improved China's international influence in the digital currency field.
A source close to BIS told Caixin that broader coordination between central banks in this area is very important, so that in the future, the digital currencies of different central banks can be transferred across borders. "It is like establishing a unified communication technology standard, it doesn't matter if you're using a Samsung, Huawei or Apple mobile phone, you can still talk to each other."
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Caixinglobal.com is the English-language online news portal of Chinese financial and business news media group Caixin. Nikkei recently agreed with the company to exchange articles in English.